Thank You

Error.

Even without the scandals, China's dairy stocks haven't always gone down smoothly with investors. The country's per-capita milk consumption is less than 30 kilograms (66 pounds) a year—a mere splash compared with more than 200 kg gulped down by Americans or 315 kg by the Swiss. China's 14 million cows barely produce enough milk to meet its own demand, and farmers have been known to pad the thin volume at the expense of milk quality.

China Mengniu Dairy,
2319.HK 0.28694404591104733%China Mengniu Dairy Co. Ltd.Hong KongHKD34.95
0.10.28694404591104733%
/Date(1425420064000-0600)/
Volume (Delayed 15m)
:
6678540
P/E Ratio
N/AMarket Cap
68293202703.5875
Dividend Yield
0.7198855507868384% Rev. per Employee
1439580More quote details and news »2319.HKinYour ValueYour ChangeShort position
with one-fifth of the domestic market for milk, yogurt, ice cream, and milk powders, has been further scarred by food-safety flubs. Its Hong Kong-listed shares (2319.Hong Kong) plummeted in 2008 after some milk powder was found tainted with melamine. After the shares recovered, a routine inspection late last year found high levels of carcinogens—blamed on allegedly moldy feed—in a batch of boxed milk before it reached consumers.

Has Mengniu learned its lesson? Analysts seem to hope so, and after a round of scoldings, 23 out of 29 analysts today rate the shares Buy. Sales in smaller hubs have rebounded to levels before the scandal but still lag in the biggest cities, putting the overall sales-recovery rate at more than 90%.

But Mengniu's shares at least are discounted, and dents to analysts' bullish estimates could provide an opening for longer-term investors. At about HK$22 (US$2.84), the shares are a fifth off late-2011 levels and fetch 19 times projected 2012 profits. That may seem high at first, until you consider multiples of 31 times for
Want Want China
(151.Hong Kong), which makes snacks and beverages, or 28 times for
Tingyi
(322.Hong Kong), which makes instant noodles and baked goods, and 25 times for
Tsingtao Brewery
(168.Hong Kong).

China also is chipping away at its milk-supply shortage, importing 55,000 cows from Australia in the first half. Mengniu's revenue grew 23.5% in 2011 while earnings expanded 28%, and management is increasing the mix of value-added products to appeal to the growing middle class.

More important, a new CEO is shifting the focus from short-term growth to improving food safety. Last month, Mengniu sold a 5.9% stake to Arla Foods of Denmark, one of the world's largest dairy cooperatives. The two will establish a milk-technology center to improve milk quality and farm production, and Mengniu will develop dairy goods bearing Arla's brands in China and abroad. Mengniu also has hired a former Coca-Cola executive to set up a quality-control regime and is consolidating its milk-supply sources and weaning itself from smaller farms and stations. And it has hired Ogilvy to rehabilitate the brand.

A CURIOUS THING HAPPENED as China's economic growth slumped to 7.6% last quarter, the worst in three years. With investment driving half of China's gross domestic product, and shoppers holding back in Europe and the U.S., there's mounting urgency to Beijing's task of rebalancing the economy toward more consumer spending. And Chinese stocks will stay volatile until Beijing succeeds. Yet Hong Kong's Hang Seng Index, which is laden with big Chinese stocks, has rallied three of the past four weeks and is up 6.5% this year.

What will China's rebalancing mean for investors? "China's seemingly insatiable appetite for all things dug out of the ground will slow," notes Citigroup strategist Markus Rosgen. Yet, tamer commodity costs could boost consumer companies' profit margins. Lately, investors have fixated on China's GDP number without asking how much of the slowdown is already factored into the market. The Shanghai Composite Index is nearly two-thirds off its 2007 high, while the Hang Seng fetches less than 10 times 2012 profits. At current levels, Chinese stocks are pricing in a 2% decline in per-share profit each year to perpetuity, Rosgen says. "Expectations are low."